RBI Proposes Revamp Of Bank CEO Compensation
Starting 2017, banks had been asked to disclose divergences of more than 15 percent in asset classification to shareholders.
Six years after the Reserve Bank of India first tightened rules for compensation for chief executive officers and whole-time directors of private sector and foreign banks, the regulator has proposed a new set of rules. If implemented in their current form, bank chiefs will see a larger proportion of their compensation come in the form of variable pay and be liable for penalties if there is a divergence between bad loan assessment of the bank and the regulator.
In a discussion paper issued late on Monday, the RBI proposed the following changes to the existing guidelines:
1. Substantial portion of compensation i.e. at least 50 percent should be variable. Earlier no threshold was prescribed
2. Employee stock options should be included as a component of variable pay. Earlier such stock options were excluded from the variable pay component.
3. Variable pay is to be capped at 200 percent of fixed pay. Earlier variable pay was capped at 70 percent of fixed pay but did not include ESOPs.
4. Minimum 50 percent of variable pay is to be via non-cash component. Earlier no specific proportion was prescribed.
5. The regulator proposes to do away with guaranteed bonuses. “Guaranteed bonuses are not consistent with sound risk management or the ‘pay for performance’ principles and should not be part of compensation plan,” the RBI said.
6. The RBI has also proposed mandating the imposition of malus (or penalties) in case of divergence in NPA/provisioning beyond RBI prescribed threshold for public disclosure. Earlier no such provision was in place.
“Banks are required to put in place appropriate modalities to incorporate malus/clawback mechanism in respect of variable pay, taking into account relevant statutory and regulatory stipulations as applicable,” said the RBI. In particular, the RBI wants banks to put such penalties in place when a divergence in asset classification is detected.
Wherever the assessed divergence in bank’s asset classification or provisioning from the RBI norms exceeds the prescribed threshold for public disclosure, the bank shall not pay the unvested portion of the variable compensation for the assessment year under ‘malus’ clause. Further, in such situations, no proposal for increase in variable pay (for the assessment year) shall be entertained.RBI Discussion Paper
Starting 2017, banks had been asked to disclose divergences of more than 15 percent in asset classification to shareholders. Private banks including Yes Bank Ltd., Axis Bank Ltd. and ICICI Bank Ltd. disclosed such divergences in FY17. Since then, CEOs of two of these banks were denied an extension of their terms.
As part of the new proposals, the RBI is also suggesting quantitative and qualitative criteria is for identification of ‘Material Risk Takers’. In addition, the regulator has suggested a set of rules for staff in compliance and risk-control functions.
“Members of staff engaged in financial and risk control should be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the bank. Effective independence and appropriate authority of such staff are necessary to preserve the integrity of financial and risk management’s influence on incentive compensation,” said the RBI.
Speaking to BloombergQuint, former RBI deputy governor R. Gandhi said the regulator’s proposals are in line with global standards on bank executive compensation that came into place after the financial crisis. While the RBI had taken the first step towards these standards in 2012-13, the next step is being proposed now as the Indian banking sector grows in size. However, he added that some of the provisions, such as the claw-back of variable compensation in the event of an asset quality divergence, is specific to India.
The question asked over the last few years was what is the regulatory approach to bank CEOs who may put banks in a riskier position. On that basis, the Reserve Bank has come out with these extra provisions.R Gandhi, Former Deputy Governor, Reserve Bank of India
Others, however, feel that the regulator must tread carefully in capping compensation of bank executives.
“Risk and reward must go together. If you cap rewards to a large extent then incentive to take risks goes away. That is what we have seen in the case of public sector banks where there are no incentives to take tough decisions,” said Ashvin Parekh, managing director of Ashvin Parekh Advisory.
The regulator has sought feedback till March 31,2019. It hopes to make the new rules applicable from the new financial year. The guidelines once approved would apply to private banks, small finance banks and payment banks. They would also apply to wholly owned subsidiaries of foreign banks.